AMERIPRISE FINANCIAL, INC. 
By 01/13/2014| David Joy
Last week's December jobs report was surprisingly weak, defying expectations of another in a recent series of strong reports. Over the prior four months, the economy had created an average of 214,000 new non-farm jobs. In December, however, the pace of job creation fell to 74,000.
The report came as such a surprise it was quickly dismissed as an aberration, blamed on bad weather. Despite the slow jobs growth, the unemployment rate still fell 0.3 percent to 6.7 percent, as the size of the labor force continued to fall. Had it simply stayed the same size as in November, the unemployment rate would have fallen to just 6.9 percent.
For all of 2013, the unemployment rate improved sharply, falling from 7.9 to 6.7 percent. About two-thirds of the improvement came from more jobs, while about one-third came from people dropping out of the workforce. The so-called labor force participation rate, or the percentage of the non-institutional U.S. population that is either working or looking for work, in December tied the October rate at a thirty-five year low of 62.8 percent, down sharply from its 2000 high of 67.3 percent.
Retirement at the Center of Declining Labor Force
The immediate reaction to this report might be to attribute the decline to discouraged workers giving up and dropping out of the workforce. But an analysis by the Philadelphia Federal Reserve concludes that since the first quarter of 2012, the entire decline in the participation rate through the end of this year's second quarter was attributable to retirement.
The report by Shigeru Fujita, entitled "On the Causes of Declines in the Labor Force Participation Rate," dated November 19, 2013 concludes that since 2000, roughly two-thirds of the overall 3.9 percent decline in the participation rate was attributable to discouraged workers, and one-third due to retirement and disability. However, the increase in retirement as a factor has occurred only since 2010, and since 2012 it has been the singular factor.
The distinction between discouraged workers and retirees is important. If the participation rate was declining primarily because of discouraged workers, it would paint a picture of a labor market that is less robust than suggested by the unemployment rate. But a fall in participation primarily attributable to retirement, while it doesn't change the total number of jobs being created, is more of a demographic shift than a comment on the strength of the labor market.
In other words, the rate of non-participation due to discouraged workers is not rising, and that is encouraging.
This distinction has important implications for Federal Reserve policy. On Friday, the same day as the release of the December employment report, as reported by Bloomberg, St. Louis Federal Reserve President James Bullard, in response to a question after a presentation to the Indiana Bankers Association, said, "We think today's labor force participation rate is about right given observed demographic trends."
Indeed, in Congressional testimony regarding the aging workforce in February 2007, then-Fed Vice Chairman Donald Kohn discussed the Fed's forecast that the labor force participation rate would decline to about 62.5 percent by 2015. In other words, the actual result, so far, is exactly what the Fed model forecast.
So, the recent decline and its cause come as no surprise to the Fed. When it says that a 6.5 percent unemployment rate is the baseline threshold for beginning the discussion of when to first raise the overnight rate, that assessment fully includes this anticipated decline in the participation rate. The unemployment rate is now just 0.2 percent away from that threshold and could reach it in the next few months, sooner than many expected.
Nevertheless, the market reaction to the December jobs report suggested that investors believe it lessened the likelihood of any acceleration in the Fed debate to ultimately tighten, as the sluggish job growth, at a time of continued low inflation, trumped the drop in the unemployment rate. The yield on the two-year Treasury note fell five basis points to 0.38 on Friday, after having climbed 17 basis points since the end of November. The yield on the five-year note fell 12 basis points on Friday, after having risen 50 since late November. And the yield on the ten-year note fell 11 basis points to 2.86 percent. The yield on inflation-protected securities fell, and Fed funds futures expectations receded as well.
Through November, the Personal Consumption Expenditures deflator had increased by 0.9 percent, and the core rate rose 1.1 percent. In President Bullard's Friday presentation he said the St. Louis Fed forecasts that both core and headline inflation will rise to 1.6 percent by this year's fourth quarter, still below the Fed's 2.0 percent target, and that unemployment will average 6.2 percent in the fourth quarter as well, a slightly more aggressive outlook than that of the FOMC. Whether these conditions would intensify the debate to begin to tighten remains to be seen. Of course, should inflation or inflationary expectations begin to rise at a faster than expected rate, investors are likely to take notice and begin to bring forward their own expectations of the future path of Fed policy.
December's job report is so far an outlier, and not just among indicators of labor market conditions. Most other measures of economic activity have been firming lately, as well. If, indeed, weather was to blame, we should see a catch-up in the January data. President Bullard noted his own expectation that the December jobs total would be revised upward.
Important Disclosures:
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The Personal Consumption Expenditure deflator measures the average change over time in the price paid for all consumer purchases.
The "core" PCE price index is defined as personal consumption expenditures (PCE) prices excluding food and energy prices.
It is not possible to invest in an index.
Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.
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Is Retirement Reshaping the Labor Force?
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